Inflation Leads To Higher Prices Economics Essay

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Inflation can be defined as the continuous rise and influential in the general level of prices in the economy. It should be noted that inflation must be associated with an increase continuously in the prices of all (or most) of goods and services in the economy.

This is the rise that is in the form of continuous and long periods of time and not the rise that is in a short span of time. In addition, this rise should be the main influential factor in the budget of individuals so as to lead the increase in the level of the general price decline in the purchasing power of individuals.

Inflation leads to higher prices, but does every rise in prices cause inflation?

Of course not, because the concept of high prices that form inflation is a relative concept. If prices reach a certain level, it becomes inflationary. For example, when prices increase on a domestic level more rapidly than on an international level, or when it continues to rise permanently, or even when the growth of wages or salaries do not equal the rise in prices, this all leads to a decrease in the purchasing power.

Types of Inflation

Demand Inflation

When the increase in prices occur as a result of increase of demand for energy productivity of the economy.

Creeping Inflation

This is an annual increase in price levels in a percentage exceeding between 1% and 3% and this determines that the small rise in the prices is considered as growth in the economy. This is mainly caused by the increase of prices of resources and the fact that leads to increased profits which encourage producers to raise the level of their investments.

Galloping Inflation

If mild inflation is not checked and if it is uncontrollable, it may assume the character of galloping inflation. Inflation in the double or triple digit range of 20, 100 or 200 percent a year is called galloping inflation.

Hyperinflation

It is a stage of very high rate of inflation. While economies seem to survive under galloping inflation, a third and deadly strain takes hold when the cancer of hyperinflation strikes. Nothing good can be said about a market economy in which prices are rising a million or even a trillion percent per year. Hyperinflation occurs when the prices go out of control.

Stagflation

It is an economic situation in which inflation and economic stagnation or recession occur simultaneously and remain unchecked for a period of time. Stagflation was witnessed by developed countries in 1970s, when world oil prices rose dramatically.

Deflation

Deflation is the reverse of inflation. It refers to a sustained decline in the price level of goods and services. It occurs when the annual inflation rate falls below zero percent (a negative inflation rate), resulting in an increase in the real value of money. Japan suffered from deflation for almost a decade in 1990s.

Joint inflation (Mixed Inflation)

This type of inflation occurs because of the high purchasing power in individuals with the survival of the size of the total output of goods and services leading to constant rise in aggregate demand.

We see from what has been mentioned above about inflation and its forms that the largest effect of inflation is that the money loses its most important function which is being the storage and measure of value. Whenever the prices increase, the value of money decreases causing chaos transactions between creditors and debtors, sellers and buyers, and between producers and consumers which leads to chaos within the economy leading to people using different currencies than their own.

Causes of inflation

Demand-Pull

In the case of demand-pull, inflation is caused by aggregate demand being more than the available supply. Aggregate demand is made up of consumer spending, investments, government spending, and whatever is left after subtracting imports from exports. Factors that commonly lead to demand-pull inflation include a sudden increase in the amount of money in an economy and decreases in taxes on goods.

Cost-Push

Cost-push inflation occurs when manufacturers and businesses raise prices as a result of shortages, or as a measure to balance other increases in production costs. An example of this is raising labor costs. When workers demand wage increases, companies usually pass on these costs to their customers. An increase in the taxes imposed on goods may lead to a cost-push situation as well, since suppliers transfer the costs to consumers.

Built-In

Built-in inflation happens as a result of previous increases in prices caused by demand-push or cost-pull. In this type of situation, people expect prices to continue to rise, so they push for higher wages. This raises costs for manufacturers, which then raise the cost of goods to compensate, causing a cycle of inflation.

Quantity

Quantity theory states that inflation is caused just by having too much money in an economy. This includes cash as well as financial instruments like investments and mortgages. It is part of monetarist economics, in which some inflation is to be expected and is seen as a normal thing, but any excess has to be controlled by manipulating the money supply.

Short-Term Causes

Other causes of inflation include wars, natural disasters, and decreases in natural commodities. Wars often result in this situation as governments must recoup the money spent on them, and repay the funds borrowed from central banks. Wars also affect international trading labor costs, and product demand, resulting in a rise in prices. Natural disasters may have a similar effect by disrupting the usual cycle of the production process. This creates a temporary scarcity as people scramble to purchase the limited supply of goods, causing the prices to skyrocket. Decreases in natural commodities, like helium or oil, can act in the same way.

Means of Control

Governments take different approaches to controlling inflation, depending on what they believe is causing it and their stance on government involvement in the economy. In the case of a demand-pull or cost-push situation, a government taking a classical economics approach would do nothing, since this approach is based on the idea that the market will naturally work itself out and get back to normal without government influence. A government taking a Keynesian approach would become involved in the economy by breaking up monopolies, regulating commodity prices, or controlling wage levels. A monetarist government, or one that believes in the quantity theory, would make changes in policy to control the amount of money in an economy.

Effects Of Inflation

The most immediate effects of inflation are the decreased purchasing power of the dollar and its depreciation. Depreciation is especially hard on retired people with fixed incomes because their money buys a little less each month. Those not on fixed incomes are more able to cope because they can simply increase their fees.

A second destabilizing effect is that inflation can cause consumers and investors to changer their speeding habits. When inflation occurs, people tend to spend less meaning that factories have to lay off workers because of a decline in orders.

A third destabilizing effect of inflation is that some people choose to speculate heavily in an attempt to take advantage of the higher price level. Because some of the purchases are high-risk investments, spending is diverted from the normal channels and some structural unemployment may take place.

Finally, inflation alters the distribution of income. Lenders are generally hurt more than borrowers during long inflationary periods which means that loans made earlier are repaid later in inflated dollars.

Inflation in Spanish

Constant inflation difference in a monetary union, unless associated with Balassa-Samuelson effects, may end up affecting competitiveness in the tradable division and jeopardizing real junction. This could be the case in Spain, which still records inflation rates above the euro area average, despite having made significant progress in the last decade.

Apart from differences in the cyclical position and in the monetary stance, inflation differentials are shown to a large extent by broken goods and labor

markets and, in particular, by an insufficient degree of competition in some protected sectors. Mark-ups in the non-tradable sector play a important role in explaining higher inflation rates in Spain compared to the euro area.

Although since the late 1980s, when Spain joined the ERM, tighter monetary policy has led inflation rates to join those in the EU. While the annual average inflation rate in the euro area between 1998 and 2003 was 1.8%, the rate registered in Spain amounted to 3.0%. This might threaten competitiveness and real junction in the medium term, especially in a country like Spain, involved in a catching up process with per capita income slightly above 85% of the EU-15 average.

Although cyclical and monetary conditions play a non-negligible role, the persistence of the inflation differential between Spain and the euro area seems to be explained mainly by structural elements. Income union, higher wage growth, coupled with lower productivity growth than in the euro area, the presence of noncompetitive behavior, and market rigidity in some sectors seem to be the key elements behind persistently higher inflation in Spain.

In particular, firms' relatively high degree of market power and ability to set prices above marginal costs is one of the major factors contributing to the inflation differential between Spain and the euro area. This is the case for a number of sectors, bringing about a well-known double inflation factor.

Moreover, the Balassa-Samuelson effect does not appear to be a significant factor in explaining the inflation differential. Thus, the increasing effect of inflation differentials might eventually jeopardize Spanish competitiveness by an appreciation of the real effective exchange rate. In this regard, liberalization programs taken on by the Spanish authorities in the recent past may ease inflation pressures.

However, they need to be complemented by measures aiming at increasing effective competition through a deeper process of market deregulation.

The lack of competition can discourage investment in research and development and thus slow down improvement, which negatively affects productivity growth.

Therefore, in order to provide a sound basis for reducing the inflation differential, effective measures to increase both competition and productivity growth are necessary.

Conclusion

In general, inflation is the rise in the general level of prices. It is also the decrease of value of cash that circulates between individuals more quickly from growing products that they can acquire.

The currency loses its value source of inflation that comes from the increase of demand or decrease in supply equally or both occur at the same time. When the increase of wages exceeds the increase of production or when rising costs of importing raw materials, such as oil or factors of production takes place, the inflation indicator will rise rapidly.

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